I'm a Fellow at the Adam Smith Institute in London, a writer here and there on this and that and strangely, one of the global experts on the metal scandium, one of the rare earths. An odd thing to be but someone does have to be such and in this flavour of our universe I am. I have written for The Times, Daily Telegraph, Express, Independent, City AM, Wall Street Journal, Philadelphia Inquirer and online for the ASI, IEA, Social Affairs Unit, Spectator, The Guardian, The Register and Techcentralstation. I've also ghosted pieces for several UK politicians in many of the UK papers, including the Daily Sport.

Frankenstorm Sandy Will Boost The US Economy

We know very well that Hurricane (or Frankenstorm as some are calling it) Sandy will leave a trail of destruction across parts of the US today. There will almost certainly be deaths, as there have been in the hurricane’s passage across the Caribbean. And there will also be a boost to the US economy. Which is really evidence of quite how wrong we are in the way that we measure the economy.

It’s often said that WWII ended the Great Depression: which it did according to the GDP numbers. Yet there’s something slightly wrong about a measure which says that building things in order to blow them up is an increase in wealth. Not to say killing lots of people in the process. We’ve also had the rather amusing thought from Professor Krugman that an alien invasion (or even the preparation for a fake one) would lift us out of our current troubles.

“If we discovered that space aliens were planning to attack, and we needed a massive build-up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in 18 months,” Krugman says, referencing an episode of The Twilight Show in which an alien threat was manufactured to bring about world peace.

While Krugman is obviously using the idea as a provocative thought experiment, there’s a serious argument behind it, which boils down to the government gaining the incentive to raise taxes so it could build war-fighting materials, much like the U.S. did during World War II when tax rates were astronomical. The war was the single biggest factor in finally helping the U.S. dig out of the Great Depression, largely because it generated jobs and exports.

And in one sense this is absolutely true. GDP would rise, more people would be employed and by certain measures our troubles would be over.

The problem with this is that it is only true because of the way that we calculate GDP. In our working of the numbers we assume that it’s final consumption at market prices: that is, the value that consumers put on everything. However, this is not true of government spending. It’s very difficult indeed to work out what government spending is actually worth: for as we’ve not a choice in it then there’s no market price nor accurate valuation from the people who actually get whatever is produced. Some government spending is most certainly worth more than the actual amount spent. The court system say: a pre-requisite of our having a complex society at all. Other parts not so much: what is the true value of a diversity adviser for example? So what we actually do is value all government spending, for GDP purposes, at the cost of that actual spending. Government spends $100, GDP goes up by $100. That’s just how we define it. This can cause amusement in measuring the success of welfare programs for example. Even Census admits that some of the people who receive Medicaid, or food stamps, value what they receive at less than the cost of providing it.

Which is how we can end up saying that building bombs to throw at people expands GDP: it’s government spending so the value is how much is spent. The consumers of the bombs, the victims, probably put a negative value on them but we entirely disregard that (which is a cheap shot I admit). That ship sunk, now rusting on the bottom of the ocean, is still counted as a rise in GDP because the government spent $10 million on it.

Those banks of massive lasers to fry the incoming alien ships would be entirely valueless given that there are no aliens. But the cost of building them would be an increase in GDP even though we’ve just extended great effort to end up with precisely nothing at all.

This is half the problem with the way we calculate GDP: government spending counts at what it costs, not what value it produces.

The other half of the problem is that we are measuring the current activity, not the capital value. This is a common complaint when we talk about pollution. Cleaning up an oil spill counts as an increase in GDP. Which it is of course: we think that cleaning up an oil spill adds value so cleaning up an oil spill does add value. That’s why we clean it up and also why we count it in GDP: our measure of value being added.

The problem is that we don’t count the loss in capital value of the original spill itself: nor of any other pollution. GDP measures the flows in the economy, not the stock.

These numbers aren’t accurate (no one really has an accurate number for the wealth of the entire US) but they’re in the right order of magnitude at least. Imagine that the total wealth of the US is $100 trillion. All the buildings, the factories, the financial assets, the human capital, the natural resources, all add up to $100 trillion. The GDP of the country is around $15 trillion. That second is the flow that we get from the stock of the first.

Now imagine that Hurricane Sandy does $10 billion of damage to that wealth (for our purposes it doesn’t matter whether it’s $100 billion or $1 trillion. Although this obviously matters to everyone except for the purposes of this example). The US is now worth $99.990 Trillion. GDP might rise to $15.01 trillion as we repair that damage. But we’re not in fact any richer at all: despite the fact that GDP has gone up. What has actually happened is that some of our stock of wealth has been destroyed and we’re having to do more work in order to rebuild it. This is exactly the same as our pollution example. We’re measuring what we produce but not the capital stock of what we have (or had).

Yes, the rebound from Sandy may well provide a boost to the economy. But that’s a function of the way that we measure that economy, not a real boost in our general wealth.

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As your text suggests, the idea of gain is a fallacy. In fact, the loss from what is today an unnecessary “day off” for 75% of the people in the affected areas is likely to be substantial. Is anyone asking whether shutting down whole systems for the sake of low- or outlying areas is logistically necessary, or whether this is done for the sake of social cohesion?

You’re absolutely correct about the loss of GDP from production being closed down today and or tomorrow. I didn’t include it because I didn’t want to get too complicated.

But as an example, last quarter’s UK GDP saw a fall. One explanation for which was that we’d all got an extra two days off for the Royal Wedding. Then, last week, when the next quarter’s GDP numbers were announced they rose. Part of the explanation being that we had not had two days off for the Royal Wedding and therefore there more days of production in the second of the quarters than the first.

So, on that, absolutely, yes.

On this though:

“Is anyone asking whether shutting down whole systems for the sake of low- or outlying areas is logistically necessary,”

I’m not too sure. Decades ago I used to live in DC. And there was a warning of a snow storm coming which would drop all of an inch over the city. Everyone closed down and stayed home. I thought this was hilarious.

Then the next winter there was a snow storm without much warning. The place was absolute chaos.

Given how appallingly everyone did deal with a small amount of snow I tend to think that, in that place at least, closing down when there might even be snow is a sensible idea.

Alvin, my apologies, but what I’ve written above is a refutation of the fallacy. Sure, I’ve not mentioned Bastiat, nor even broken windows. But what’s up above is indeed an explanation of why the fallacy is a fallacy.

Because we don’t take account of the original destruction, the reduction in wealth, that leads to the greater economic activity.